New federal legislation made sweeping changes in retirement plans. Here’s what you need to know.
The new year has brought a number of changes in financial rules affecting consumers.
Many of them are in new federal legislation called the Secure Act, which mostly applies to retirement plans but also has provisions that help new parents and those with student loans.
Another opportunity for savers is an increase in 401(k) contribution limits, which are set by the IRS.
Here’s a checklist of the biggest changes and how you can make the most of them.
Save More in Your 401(k)
Many Americans can take advantage of the higher contribution limits in 401(k) plans. You can put away as much as $19,500 in 2020, up from $19,000 last year. Those 50 and older can also contribute a maximum of $6,500 this year in so-called catch-up saving vs. $6,000 previously. All told, someone 50 and older can save as much as $26,000 this year.
The contribution limits for Individual Retirement Accounts (IRAs) remain unchanged this year at $6,000; you can put in as much $7,000 if you’re 50 or older.
What to do: Raise your 401(k) contribution as much as you can. (If you don’t have a plan, take full advantage of IRA options.) Most planners suggest putting away as much as 12 percent to 15 percent of your pay, an amount that may include an employer match. Because the money is usually taken out before taxes, you might not miss it as much as you think. (This calculator will show you the impact of your pretax contribution on your take-home pay.)
Delay Using Retirement Funds
The Secure Act allows you to wait longer before you have to start withdrawing money from your qualified retirement accounts, such as your 401(k) or IRA.
The new age limit for required minimum distributions (RMDs) is now 72, up from 70½. The change applies to those turning 70½ after Jan. 1, 2020. This delay gives your money a bit more time to grow in a tax-sheltered account while postponing your tax bill.
What to do: Even if you have more time to wait, it’s still crucial to take your distribution on schedule. If you miss your RMD, you will end up owing a 50 percent penalty on the amount. That’s on top of the ordinary income tax you must pay on the money you withdraw. (Read more about calculating your RMD.)
Fund a Traditional IRA After 70
The legislation also repeals the maximum age for making traditional IRA contributions, which had been 70 1/2. You will now be able to contribute to a traditional IRA past this age as long as you have earned income. (Roth IRAs have no age limits on contributions.)
What to do: If you can keep working past the traditional retirement age of 65, there are good reasons to do that. In addition to the financial boost it can give you, working longer provides health and social benefits, studies show.
Limiting Benefits of Inherited IRAs
A long-standing estate planning strategy known as a “stretch” IRA has been mostly eliminated by the Secure Act. It allowed beneficiaries to stretch out distributions from IRAs they inherited based on their life expectancy. That way, grandchildren or other young beneficiaries could keep much of that IRA money invested for decades before having to pay tax on it.
Under the new rules, if you inherit an IRA from an original owner who passes away after Jan. 1, 2020, you must withdraw all the assets within 10 years of his or her death. (The rule changes do not apply to those who have already inherited an IRA.)
There are exceptions to the 10-year distribution requirement. You may still be able to stretch out IRA distributions over your lifetime if you are a surviving spouse, a minor child, a disabled or chronically ill individual, or a beneficiary less than 10 years younger than the deceased account owner.
What to do: If you intend to leave an IRA inheritance, it’s best to speak to your tax adviser or estate planning attorney as soon as possible. Chances are you will need to update your plans.
Use 529 Plan to Pay Student Loans
The Secure Act expands the definition of a tax-free distribution from a 529 college savings plan to include repayment of qualified student loans. Under this provision, you can put money in a 529 account, then make withdrawals to pay up to $10,000 in student loans and still get a state tax break.
What to do: It’s essential to first check whether your state 529 plan will allow this as a qualified withdrawal and how quickly contributions can be taken out.
State plans follow their own rules, which may not fully conform with the changes in federal regulations.
Some states will need to pass legislation to allow 529 money to be used to pay student loan debt, says Mark Kantrowitz, publisher and vice president for research at Savingforcollege.com, which has analyzed how these withdrawals might be treated under individual state plan rules.
If a state does not allow student loan repayment as a qualified expense, those distributions are subject to state income taxes on the earnings portion of the withdrawn amount, plus recapture of state tax breaks on that money.
New Parents Can Take 401(k) Withdrawals
New parents are permitted to withdraw up to $5,000 from a 401(k), IRA, or other qualified retirement plan without paying a 10 percent additional tax for early distributions. You must make the withdrawal within a year of the birth or adoption of a child. You will still have pay ordinary income taxes on the withdrawal. You can later repay the money into your account.
What to do: It’s likely to take some time before most plan administrators have set up this withdrawal option. If your plan does offer this benefit, think twice before making a withdrawal unless you face a serious cash crunch. You will be giving up the long-term growth of those assets.
Watch for More Changes
For those who work in small and midsized businesses that lack a 401(k)—about half don’t offer one— the Secure Act provides an incentive to create a plan.
Under the multiple employer provision, unrelated small businesses can join together to establish a 401(k) and receive tax breaks. By pooling assets, moreover, these employers may have more leverage to get reduced fees from plan providers.
The Secure Act also offers a provision designed to encourage employers to offer annuities in their 401(k)s. Few plans do so now, but many retirement experts favor annuities as a way of giving workers a guaranteed stream of income that lasts a lifetime.
But consumer advocates worry that smaller 401(k) plans might end up adding high-cost annuities. And many workers are reluctant to lock up their money in one of these products.
What to do: If your employer doesn’t currently provide a 401(k), let it know about the option of creating a multiple employer plan. You will also want to keep an eye out for more changes in your plan’s retirement income offerings.